ROS (Return on Sales), what is it, formula and how to calculate it

The ROS index (Return on Sales) is one of the most used balance sheet indicators in fundamental analysis to evaluate the solidity of a company and to understand whether it is worth investing in the stock issued by the company being studied.

The ROS is, therefore, part of the family of indices that includes the ROI index (Return on Investment), the ROE index (Return on Equity), and the ROA index (Return on Assets), to give some examples.

Those who use the ROS index in the evaluation phase can understand the company’s profitability in relation to the turnover achieved. But let’s go into more detail to find out what the ROS is, how it is calculated through the reference formulas and what are the characteristic points of this balance sheet indicator.

What is the ROS (Return on Sales) Index: the meaning in economics

The ROS (Return on Sales) Index, known in Italian as Rendimento sulle Vendite, is a financial indicator that measures the operating profitability of a company concerning the volume of its sales. In simple terms, the ROS indicates how much net profit margin the company can obtain for each euro of sales.

This indicator focuses on operational management, measuring the actual earnings of a company after covering the costs of production, distribution, and administration, but before taxes and interests. Consequently, the ROS is useful for understanding the effectiveness and efficiency of the company in managing its costs in relation to revenues.

Return on Sales (ROS) is a balance sheet indicator widely used in the evaluation of a company and a potential investment in a stock. Together with other indices - such as ROE and ROI - it allows the user to evaluate the profitability of a company.

ROS differs from the other profitability indicators mentioned because it focuses exclusively on sales, excluding investments or equity capital. This makes it an essential parameter for companies that operate in sectors with high sales volumes and low operating margins, such as retail, large-scale distribution, or the food sector.

What is the purpose of the ROS balance sheet index?

The ROS index serves primarily as a financial analysis tool to evaluate the profitability and efficiency of a company. It can be used by business managers, investors, and financial analysts to:

• evaluate operating efficiency: ROS allows you to monitor how the company manages its operating costs in relation to revenues. A high ROS is generally an indicator of good cost management, which means that the company is efficient in its sector. If the ROS is low, however, it means that a good portion of revenues is absorbed by operating costs, reducing profit margins;
• compare company performance over time: by analyzing the trend of ROS on an annual or quarterly basis, the company can monitor whether its management strategy is generating better or worse results over time. For example, a growth in ROS compared to the previous year can be a sign of improved operating efficiency or a winning strategy in terms of cost control;
• compare a company with its competitors: ROS is also a valid parameter for comparing the company with competitors in the same sector. Since each industry has its own characteristics, a ROS of 10% can be good for the retail sector, while it could be low for a technology company. By comparing the ROS of similar companies, one can assess how the company is positioned compared to the competition;
• support strategic decisions: ROS can indicate whether the company is operating profitably. This is crucial for making strategic decisions, such as market expansions, new product launches, or investment projects. For example, if the ROS of a market segment is low, the company may decide to reduce investments in that sector to allocate resources to more profitable areas;
• signal cost problems: a declining ROS can be a sign of cost problems, such as increases in operating expenses or inefficiencies in production. In this case, the ROS index provides an early warning, allowing managers to investigate the causes and implement the necessary corrections to improve profitability.

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How to calculate ROS: the reference formula

Calculating the ROS index is simple, but it is essential to use the correct data to obtain an accurate value.

It is the simple ratio between the operating result and the net revenues achieved in a given period of time. The ROS, as with other balance sheet indicators, is expressed as a percentage.

• ROS = (Operating Profit / Sales Revenue) x 100

Where:

• Operating Profit: also known as EBIT (Earnings Before Interest and Taxes), represents the operating income before the payment of interest and taxes. It is a direct measure of how much the company earns from its main operations;
• Sales Revenue: is the total revenue generated by the sales of the company’s products or services.

This formula allows you to obtain a percentage indicating the proportion of revenues transformed into operating profit. For example, a ROS of 15% means that the company generates 0.15 euros of operating profit for every euro of sales revenue.

How to use the ROS index

• Comparison with the company’s history: analyzing the ROS over a period of several years allows you to understand whether the company is growing in terms of operating profitability. An increase in ROS over time can indicate an improvement in cost management or revenue growth faster than operating expenses.
• Industry analysis: comparing with the average ROS of the industry helps you understand whether the company is aligned, superior, or inferior to competitors. For example, in the retail sector, a ROS of 5-10% can be considered acceptable, while in sectors such as technology, it can be higher.
• Identify inefficiencies: If your ROS is lower than the industry average, it can indicate operational inefficiencies. In this case, it is useful to analyze costs in detail to identify areas for improvement. For example, excessive spending on logistics or materials can significantly reduce ROS.
• Forecasting and strategic planning: Monitoring ROS helps you make predictions about your company’s ability to generate future profits. If you expect operating costs to increase, it is important to anticipate the impact on ROS and adopt cost control strategies.
• Risk assessment: ROS can also be useful for risk management by flagging vulnerabilities related to specific industries. For example, in the event of an economic downturn, companies with low ROS may struggle to maintain profitability, which can indicate greater risk for investors.
• Investment decisions: For investors, ROS is useful for assessing a company’s potential profitability. A stable and growing ROS signals solidity and sound operational management, making the company an interesting investment compared to companies with low or variable ROS.

However, it must be said that ROS alone does not tell us much about the company’s ability to remunerate shareholders nor does it tell us whether the company is improving or not in terms of debt. Consequently, this index is always used in conjunction with other indicators, such as ROE, ROI, or ROA, which, instead, tell us the company’s ability to remunerate shareholders and to be able to manage debt levels.

Original article published on Money.it Italy 2024-10-30 18:29:13. Original title: ROS (Return on Sales), cos’è, formula e come si calcola